Dimensions: 8.25'' x 5.5'' 96 pages AEI Press  (Washington) Publication Date: February 2000 Paperback ISBN: 0-8447-7147-3 Price: $ 9.95 Add to Cart   Examination Copies

February 2000
Prices, Markets, and the Pharmaceutical Revolution
By John E. Calfee 

Although pharmaceutical costs have aroused controversy for decades, debate has intensified over the past year. Proposals to add a drug benefit to Medicare are being floated, which raises the specter of price controls. This book explains why efforts to control drug prices through political means are deeply misconceived and could thwart today's dramatic improvements in health.

John E. Calfee is a resident scholar at AEI and the author of Fear of Persuasion: A New Perspective on Advertising and Regulation.

This book begins with a single fact--spending on prescription drugs is rapidly increasing--and then proceeds through a series of questions, as each answer raises the next question. Ultimately, the reader is left with the view that profit-seeking pharmaceutical research and development is bringing unprecedented benefits to millions of consumers and will continue to do so--unless Congress or the state legislatures interfere by imposing price controls or a misconceived plan for Medicare coverage of prescription drugs.

The starting point is expenditures for prescription drugs, which doubled (in real terms) between 1990 and 1998, increased another 15 percent over the past year, and will probably continue to increase by 10-15 percent annually for the foreseeable future. The trend is quite general and encompasses managed care, the elderly, and even many health care systems abroad.

Higher prices are not the main source of expenditure increases: roughly three-fourths of the increases pay for innovative new drugs and the greater usage of existing drugs. The new drugs are the product of the "third revolution" in pharmaceutical research (after the development of antibiotics in the 1940s and of drugs based on an understanding of disease mechanisms in the 1960s and 1970s). The new generation of pharmaceuticals is accomplishing two things. First, it is creating breakthrough medications for heart disease, diabetes, osteoporosis, arthritis, and other illnesses, as it moves far beyond anything achieved in earlier waves of research. Second, the new drugs are offering valuable therapies to many people for conditions previously regarded as not being amenable to medical care--including mild depression, mild obesity, moderately elevated cholesterol or blood pressure, and high risk for osteoporosis.

Those developments are saving lives, preventing illnesses, and alleviating pain and suffering on a scale never before achieved. For example, new drugs can cut the risk of heart attacks for millions of middle-aged men by a third and can allow many arthritis victims to lead relatively pain-free lives--at a daily individual cost lower than the price of a cappuccino at Starbucks. No wonder physicians and patients are spending more on drugs.

Two factors moderate the trends toward greater expenditures for pharmaceuticals. One is the reductions in other health care costs (when clotbusters prevent catastrophic damage from heart attacks or strokes, for example) and in workplace costs. Another is the quicker pace of competition for new drugs: because the period of single-brand dominance has shortened significantly, price competition has intensified.

The current revolution in pharmaceutical research partly results from advances in molecular biology and faster review by the Food and Drug Administration. But this revolution, unlike its predecessors, is driven as much by the market as by science. Computer simulation has drastically shortened the most tedious early stage of new drug exploration; a new, for-profit industry for conducting clinical trials has greatly expanded the scope and pace of new drug testing; managed care and the emerging discipline of disease management have contributed massive data sets and high-quality clinical testing; venture capital and flexible labor markets have forged academic-industry partnerships and a multitude of biotechnology startups; and advertising and promotion have accelerated pharmaceutical research and the adoption of new drugs.

That marriage of science to the most dynamic sectors of the U.S. economy is still in its early stages. Each of its constituent parts is rapidly advancing. Medical researchers are looking forward to preventing Alzheimer’s; curing schizophrenia; reversing heart disease; striking without error at cancer cells; reducing the estimated 350,000 deaths annually from obesity; preventing 10,000 amputations a year caused by diabetes; delineating the physiological foundations of neurological diseases like multiple sclerosis and Parkinson’s; discovering new antibiotics for tuberculosis; finding AIDS cures; creating the next generation of antidepressants for the 60 percent of patients who cannot or do not use existing drugs; developing vaccines for AIDS, malaria, and other infections; and improving the quality of life for patients through cancer therapies that would not destroy ovaries, for example, or through insulin and biotech pills that would replace injections.

Those remarkable advances are best understood not just as a series of breakthroughs in pharmaceutical research, but as a parallel to developments in other high-technology industries, where the dominant themes are the exploration of new applications and an explosion of investment and spending. Like computers, the Internet, and telecommunications, pharmaceuticals are doing more than ever before, and the pace of advances continues to accelerate.

Nobody knows how much he will want to spend on pharmaceuticals in five or ten years because nobody can know what drug therapies will be available. If someone developed a drug that extirpated breast cancer from the body and sold it at a price of, say, $15,000 per case, we should hope that pharmaceutical expenditures would immediately jump by another $10 billion or more. That amount would be a bargain by any standard. But we cannot know what is coming in the next decade, and we cannot know what the next blockbuster drugs will be worth to consumers or to health care plans and other third-party payers.

That we cannot predict what new drugs will be introduced is only a part of the problem. Some of the most important advances emerge from a feedback process: a breakthrough drug stimulates new research, which establishes new uses for that drug even as it opens avenues for developing entirely new drugs:

• The clotbuster tPA was approved for the treatment of heart attacks. Additional research showed that it could treat strokes, which were previously untreatable. Now, competing manufacturers are testing drugs that will extend the window of opportunity for treating strokes from three hours to six.
• The cholesterol-reducing "statin" drugs reduced the occurrence of heart attacks in high-risk patients and provided the missing proof of the connection between cholesterol and heart disease. Further research showed the drugs could cut the risk of heart attacks by a third or more for relatively low-risk patients. Now researchers are exploring previously unsuspected mechanisms by which cholesterol causes heart attacks.
• The new generation of medications for arthritis pain has stimulated research on how the same pharmaceutical mechanism (suppressing the Cox-2 enzyme) could be used to fight cancer.

Price controls for pharmaceuticals are always politically attractive. Low manufacturing costs invite regulators to cut prices below the amount necessary to cover the costs of research and development. High profits, required to compensate for risk and past research expenditures, can be cited--mistakenly--to justify controls. The dominant role of third-party payers, including government, virtually ensures political pressure on pharmaceutical pricing.

But the expectation of selling drugs at a certain level of profit is the inducement for pharmaceutical research in the first place. Price controls would undermine the incentives to undertake the mammoth investments essential to realizing the bright promises of genomics and other new paths in medical research. The potential impact of controls was obvious during the 1994-1995 debate over the Clinton health care plan, which would have capped the prices of innovative drugs. The pharmaceutical industry scaled back its annual increases in R&D spending to less than 4 percent, far below the average of 11 percent for 1981-1993. (The lowest annual increase during that span was 7 percent.) After the Clinton plan was defeated, the spending gains for research averaged nearly 12 percent annually for the years 1996-1999.

Once in place, price controls have a life of their own. Their increasing complexity invites buyers and sellers to "game" the system through manipulation and deceit, which prompt the creation of enforcement mechanisms that burden the innocent along with the guilty. Some parties gain from controls, and they tend to become entrenched vested interests. Innovative research, information dissemination, and other essential subtleties of the modern pharmaceutical market fall prey to the inevitable clumsiness of regulation. Should pharmaceuticals become part of the traditional Medicare system, prices controls would almost certainly expand to encompass drug therapy, just as they already regulate the prices of all other products and services reimbursed by Medicare.

Experience has shown that price controls are extremely difficult to dismantle. At their worst, controls foster a stable regime in which government regulators and favored producers are comfortable with reasonably predictable prices and costs, while patients and consumers remain only vaguely aware of the health benefits that are never discovered because the necessary research is delayed or curtailed. The Japanese pharmaceutical market is a telling example.

Congress should recognize the crucial role of profits in further advances in drug therapy. It should also realize that bringing breakthrough drugs to market is a boon rather than a curse for patients, even if the drugs’ initial prices--before competition brings alternatives to market--are high to cover the huge costs of research.

The avoidance of price controls is paramount. The imposition of controls over prices or consumer expenditures would cut off the very train of events that has brought so many superb drugs to market in recent years and would forestall an even brighter future for pharmaceutical research.

Finally, Congress should approach the addition of a Medicare drug benefit with caution. Medicare's traditional fee-for-service approach is utterly unsuitable for pharmaceuticals because it virtually guarantees price controls. Alternative approaches deserve careful scrutiny. The Clinton administration’s 1999 proposal, for example, illustrated the ease with which controls could be established in a plan that ostensibly relied upon nongovernment firms to administer a Medicare drug benefit. A far better approach would be some form of voucher for market-generated pharmaceutical insurance plans that incorporate features, including substantial deductibles and copayments, based on sound economic principles.